Sam Tarantino was a freshman business student at the University of Florida in 2006 when he co-founded Grooveshark, a music-sharing site that allows users to upload their music and listen to free streams. There were other music-streaming websites, but none that Tarantino much liked. His goal was to make streaming a song as easy as finding and playing a video on YouTube. By his sophomore year, he had dropped out of school to commit himself to the business full time.

From the outset, Tarantino figured he would encounter resistance from the major record labels; his hope was to partner with them. That's what had happened with EMI, which filed a copyright-infringement suit against the company in 2009 but settled late that year, after the parties came to a licensing agreement. Other labels were a tougher sell. "I was 19, 20 years old, with zero credibility, and trying to get deals done," Tarantino says. "It was tough." Still, he had reason to be optimistic. By 2009, the number of monthly active users hit 6.5 million, and the site began earning advertising revenue.

But in January 2010, Universal Music Group sued Grooveshark in New York State court for copyright infringement. The suit argued that songs recorded before 1972 were not covered by the Digital Millennium Copyright Act, a 1998 law that permits websites to host user-uploaded content as long as they grant copyright holders' requests to remove infringing material. If successful, the suit would remove millions of songs from Grooveshark's platform.

The Problem

Tarantino was concerned, but the site was growing--it now had 24 million users and revenue of $5 million. Even better, the company broke even in 2010. And so he continued to fill his ranks with University of Florida dropouts. He and his employees were having a blast: There was music blaring and, when new user milestones were reached, kegs flowing to celebrate. The company opened offices in Denver, Los Angeles, and New York City and planned new ones in Buenos Aires and London.

In August 2010, the company was booted from Apple's App Store. Apple cited a "terms of service" violation, but Tarantino thinks it made the move at the behest of Universal. (Google blocked Grooveshark from its Android Market in April 2011. Neither Google nor Apple would comment for this story.) As a result, Grooveshark was essentially locked out of the growing mobile music market. Nonetheless, revenue soon topped $10 million.

Then, in November 2011, Universal sued again, this time in federal court, alleging Grooveshark management was encouraging employees to upload songs onto the platform. Sony and Warner Brothers joined the suit in December. This time, the labels were asking for $150,000 in damages for each of the thousands of songs they claimed violated their copyrights. John Rosenberg, partner at Rosenberg & Giger, the law firm representing Grooveshark, was not surprised. "Part of the strategy of the major labels," he says, "is to burden start-ups that they view as threats with enormous legal fees to try to bring them to their knees."

The Decision

With legal fees mounting and a payroll of 150 employees, Tarantino realized that Grooveshark was dangerously low on funds. He hoped the bad news of the lawsuits would be offset by a high-earning first quarter of 2012 and he would be able to use the surplus for the looming deficit. The big first quarter didn't happen.

Tarantino felt he had just one option--layoffs. This was particularly difficult at Grooveshark, as he considered most of his workers to be friends. "But," he says, "there's only room in the lifeboat for so many, or else we're all dead." He broke the news at a weekly Friday town hall meeting in January. Grooveshark's Denver and L.A. offices would be closed, he said, and plans to expand to the U.K. and Argentina scrapped. The sales force would be consolidated in the company's New York City office, and the Web development team moved into a new office in Gainesville, Florida. Seventy employees--almost half the work force--either were laid off or left voluntarily. One of the hardest layoffs came when Tarantino let go a friend of his since high school. "That one was especially tough," he says. "No CEO wants to be put in that situation." But the layoffs were necessary, Tarantino says, and not only for financial reasons. They also put an end to Grooveshark's frat-house atmosphere and shifted focus back to its original goal of delivering the best free music-streaming service on the Web. And for the first time, Grooveshark started a public relations department to address its poor press image.

The Aftermath

The legal woes have not let up. In August, EMI, the only major label to license its music to Grooveshark, sued the company for copyright infringement. Meantime, wary of tough copyright laws, Grooveshark pulled out of the German and Danish markets. And bad press from the lawsuits--as well as tough new rivals, like Spotify--led many U.S. users to jump ship, sending the number of users down by more than half, to 13 million. Still, Tarantino says he expects 2012 revenue to be consistent with what the company took in last year. Over the summer, Grooveshark consolidated three offices into a single space; rather than hiring movers, the remaining employees pitched in, which Tarantino says was a morale-boosting experience.

The most promising development, however, is a New York State judge's ruling that the DMCA applies to songs recorded both before and after 1972; Universal is appealing that ruling. The judge also ruled that Grooveshark could countersue Universal for damages. Tarantino and his legal team are optimistic. "As a matter of litigation momentum, it's a really significant victory," Rosenberg says. The federal suit brought by the three labels remains in the early stage of discovery.

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The Experts Say...

Find a Way to Make Everybody Happy

Going through the courts can be a lengthy and expensive process. One thing that Grooveshark shares with the labels and the publishers and the artists is that all of those parties want to see revenue. I think Grooveshark should build an infrastructure that would allow it to work directly with rights holders in more of a straight-up licensing kind of model. It's a big risk to just play the court card and hope the next judge, or the appeals judge, finds for you.

--Michael McGuireVice president of research, Gartner Research

Retool the Company's Image

Oddly, these kinds of copyright cases can depend heavily on the public perception of the company. For Grooveshark, it could come down to whether a jury or judge believes the company has made a sincere effort to stop the illegal sharing of copyrighted music. The company should try to alter its image by encouraging users to upload only freely licensed music and Creative Commons licensed music. Meanwhile, it should act like its own record label and look to form licensing deals with unsigned musicians.

--Mitch StoltzStaff attorney, Electronic Frontier Foundation

Find a Plan B

Tarantino needs to put an alternate strategy in place. A simple way to move forward would be for Grooveshark to pivot a little bit, change its focus to smaller labels that it can get rights from easily. If they just kind of dig in and continue to do what they have been doing, they're fighting an uphill battle. Pivoting would benefit morale and business.